Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part three of this edition, we're rejoined by Kristiaan Rehder, portfolio manager of the Bennelong Kardinia Absolute Return Fund.
The Motley Fool: With the changing economic dynamics in 2022, are there any sectors you're likely to avoid over the coming months?
Kristiaan Rehder: If you go back in history, whenever you go through an economic recession or serious slowdown, the one subclass that always does poorly is zero earnings stocks. That's without exception.
So, for most of this year, we've avoided this class as well as the high-multiple, expensive names. We've also avoided consumer discretionary names because we believe the pressure that the central banks are putting the consumer under is going to have an effect on spending.
An obvious sector that is on the front line of those thematics is the high-multiple tech sectors. Early in the year, we were heavily short the tech sector. But given how dramatic the falls have been, we've been taking profits from the tech sector shorts.
MF: Which sectors look promising in the coming quarter?
KR: We're remaining alert to acquiring quality businesses at cheaper prices in this market selloff. That's what we've been doing in this past week.
We're looking to add some exposure to the high cash flow energy sector. And also looking to selectively add resource names to the portfolio in the event of a more comprehensive stimulus program out of China. But we'll do that cautiously and selectively.
We're staying away from the developers and the explorers and looking at the producers, which are trading cheaply and are generating a lot of cash at the moment.
MF: Which S&P/ASX 200 Index (ASX: XJO) shares are you most confidently long on at the moment?
KR: We've got a decent position in National Australia Bank Ltd (ASX: NAB).
We think banking margins will be stronger than expected. Given the larger-than-expected rate hikes by central banks, it wouldn't surprise any of your readers' that the banks have been slow to lift deposit rates but have been quick to pass on lending rates. In that situation, you see an expansion of margins.
So far, the sector has been benefiting from a benign outlook for bad debts, given their liquid balance sheets and their strong capital positions.
The large caveat over all of this is whether the Australian economy can skate around an economic recession. I think that will be clear in the next three months.
Another large position of ours is ResMed Inc (ASX: RMD). It's a sleep apnoea device manufacturer. A clear leader in an attractive market with long-term, realisable penetration upside.
Its major competitor, Philips (Respironics), is suffering a material product recall at the moment. So, we're expecting ResMed to continue to gain market share in that space.
And Pilbara Minerals Ltd (ASX: PLS) has been a longstanding favourite of ours. I think we spoke about this one last year.
It's performed very strongly since then. The stock is up 50% this calendar year, after a 270% rise in 2021. So, maybe some of the best returns are behind it. But it continues to offer high-quality exposure to that green energy thematic, via its long-life, low-cost lithium mines in WA.
MF: What do you see as the biggest threat for ASX investors in the year ahead?
KR: Earnings downgrades, given the risk of recession, remains the biggest threat to markets by far.
I think history would suggest that the soft landings, which currently central banks are quick to point out have occurred in the past, are actually very hard to do. If you listen to central banks, they constantly refer to soft landing from the past, such as 1965, 1984 and 1994. But in those years, inflation was far lower than what we're experiencing today.
A better comparison, in our minds, is periods of high inflation and low unemployment, which are the two factors that we're seeing today.
If you go back through history, there are four periods in the post-war era where those characteristics occurred. The most recent was in the mid-2000s, just before the GFC. Inflation was above 4% due to higher energy prices, with low unemployment. In all four instances, the economy ended in recession. And that suggests that this latest inflation period could end in some sort of recession too.
There's an argument the US is already in a recession. But I think it will all become clear in the next three months.
MF: And what's the biggest opportunity for investors over the coming months?
KR: As far as this year is concerned, we're not sure this is the year to be taking enormous risks. It's more about protecting capital. It's still very risky out there, so not losing capital is really the name of the game.
That doesn't mean we aren't looking at companies from the long side. We've got an extensive list of companies we like that exhibit the kind of winning attributes we look at. Such as a robust balance sheet, strong management team, growing market, and growing market share.
But we've held off purchasing a number of these names because we just couldn't get comfortable with valuations. Now valuations are coming back into that buy zone with the recent market fall. So we're starting to add a number of these names to the portfolio.
That's certainly where the opportunities sit. Quality names which have been marked down with the broader market selloff. Which have resilient earnings that will do well over the next two to three years.
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If you missed part one of our interview with Kristiaan Rehder, you can find that here, and part two right here.
